Funds look to agricultural commodities as inflation hedge

Written by Catherine Hornby (Reuters)
Wednesday, 19 August 2009 20:25

AMSTERDAM - Less than two years after a surge in global food prices caused panic and riots around the world, investors are starting to return to vegetable oil markets and raising the spectre of renewed food price inflation. Billions of dollars change hands annually in the markets for palm, soybean and other vegetable oils, which are used in cooking oil as well as products ranging from margarine to soap and for biofuel.

Prices of vegetable oils plummeted with other commodities at the end of 2008, many halving in value on concerns about demand in the global economic downturn, as funds that had fuelled the earlier surge in prices baled out of markets. But analysts expect large investors to move back into vegetable oil markets in anticipation of a pick-up in demand for food in emerging markets, as well as greater competitiveness of biodiesel for fuel if crude oil prices rebound.

"Over the last couple of months, more and more pension funds are looking for a hedge against inflation," said Dirk Jan Kennes from Rabobank's Food & Agribusiness Research and Advisory unit, when discussing the outlook for vegetable oils. "They've calculated strong inflation figures over the mid to long term and see agricultural commodities as a hedge for that."

But traders were divided as to whether the funds are likely to move the markets as much now as they did in 2007/08. "The impact and the volume from funds may become less important," said one vegetable oils trader. "Many funds have lost a lot of money, and the banks, which own a lot of these funds, can no longer afford to go and simply speculate after asking the authorities to intervene and give support," he said.

Others said the funds were likely to resume similar patterns of speculation in markets if regulation was not toughened up and expected increased volatility going forward. "If we still continue with a lack of regulation, funds are very likely to come back and speculate heavily," said Ernesto Zamudio, a UK-based trading manager at oils and fats manufacturer AarhusKarlshamn (AAK)

Market nerves

Analysts said that despite the recent price setback, the long-term fundamental drivers that caused vegetable oil prices to rise last year were still supportive.

"If economies recover, there is a potential that demand growth catches up very quickly and supply will have trouble meeting demand. We then expect nervousness in the market and see a chance for a boom as seen in 2007/08," said Kennes. Prices of palm, rapeseed and soybean oil surged to record peaks in early 2008, as funds speculated on rising demand for commodities, adding to panic around the world about rising food prices and competition from an expanding biofuels industry.

While rapeseed and soybean harvests could pressure markets in the short term, prices may start rising strongly again as early as the start of 2010, market experts said. A recovery in the price of crude oil would make vegetable oil-based biodiesel a more competitive form of fuel. "When we have an economic recovery, you will first see it in crude oil prices, and when crude oil prices go up then demand for green energy kicks in: for biodiesel, and for co-generation," one vegetable oils trader said. But some were sceptical about whether debt-laden governments would be able to give the industry the support it needs, as the focus also shifts to non-food based feedstocks for biofuels.

Asia demandDemand for vegetable oil as food is on the rise in the long-term too. Demand for cooking oil in Asia could resume its recent high rates as economies get back on track. "It will all depend on the emerging markets like China and India. If we are facing an economic recovery, these emerging markets will continue growing at the same rate as they have in the past," Zamudio said.

In Europe, demand for vegetable oils has declined slightly in the economic downturn, though not as drastically as demand for big ticket items such as cars, with people still continuing to buy essential items in the recession. Some traders said that while cheaper oils such as palm oil were favoured during the downturn, the more expensive oils may benefit from renewed demand as economies start to recover.

"When people stop looking at the cost they may be looking at better qualities and healthier blends," said Zamudio, adding that this could help oils such as rapeseed and sunflower oil, which contain relatively lower levels of saturated fat.